Investor Capitalism: How Money Managers Are Changing the Face of Corporate America. Managerial capitalism ascended during the century’s middle decades. “The decisions they made often affected the lives of thousands of people, yet they were seemingly accountable to no one.” The large holdings of institutional investors and the growth of indexing as a major investment strategy have prevented the ready selling of underperforming companies; investors are now more likely to “speak out than to cash out.” Whereas managerial capitalism tolerated a host of company objectives, Useem argues that under investor capitalism enhancing shareholder value has become paramount.
According to Useem, the struggle for corporate control is no longer “just another squabble among the rich and powerful,” since most Americans now “derive a substantial fraction of their current or future livelihood from the performance of companies whose stock they directly or indirectly own through pension funds and mutual funds.” Critical to the book’s many informative insights are a series of interviews the author conducted between 1991 and 1995 with a wide array of corporate and investor executives. The result, is a rare behind the scenes look at how “investor capitalism” is reshaping the corporation.
The dismissals of top executives at GM, Digital, IBM, Kodak, Kmart, and others were only the “most visible edge of a more widespread development.” “Shareholders can replace directors, directors can replace managers, and managers in turn can replace shareholders.” Each party is now on a more equal footing. Institutional investors put out their Focus List but corporations now use their investor relations staff to hold “shareholder mix” campaigns. Such campaigns usually seek to increase the holdings of employees and individual investors with modest holdings, since they are most likely to vote with current management.
We hear a lot about empowered and activist shareholders. Yet, only 6% of 375 major firms surveyed in 1992 received a single director nomination from an institutional investor. Another study cited by Useem shows that “directors’ careers bear little or no relationship to their performance on behalf of shareholders.” Instead, career moves are more likely to be linked to performance on behalf of management.
The book contains a wealth of information and behind the scenes examples. Useem’s description of an executive’s frustration with pension fund managers in comparison with mutual fund managers is particularly interesting. “Mutual fund managers pay more attention to strategic directions, product performance, and prospective risks. Strong pension managers, by contrast, seem more preoccupied with the formalities of governance.”
For the CEO the “challenging–and useful–questions lay in product strategy rather than broad policy.” This guided how he allocated his time. However, with the average mutual fund turning over their stock every 6 months, instead of once every 7.5 years for the average public pension fund, I have to wonder if the vision of this and similar CEOs might be just a little short sighted, especially given the importance that “corporate governance” issues may play as money moves more widely abroad.
Useem points to the recent dramatic increases in the global market. Capitalization of the Hong Kong market, for example, went from $74 billion in 1988 to $385 billion in 1993. Prior to 1990, 20% or less of new equity investments went to foreign stocks; by the beginning of 1994 that was up to 40%. These investments have displaced the investments of the World Bank, national governments and private creditors as the largest source of external financing. International bodies are harmonizing accounting and securities standards. The Department of Labor requires pension fund managers to cast informed proxy votes with the same diligence as in the U.S. CalPERS has announced a program to expand international holdings from 13% to 20% of its assets. Convergence is seen as a major theme.
Convergence is also carried over when Useem brings the split between corporate and money managers down to the personal level. Company executives see each other at the Business Roundtable, Committee for Economic Development and Bohemian Grove. “They frequent the same clubs, sometimes the same schools, occasionally the same islands.” Those presiding over public pension funds and investment companies, however, remain remote from the “higher reaches of traditional business community.” Their networks instead lead to such professional circuits as the New York Society of Securities Analysts and the Association for Investment Management and Research. For Useem, as a professor at the most highly rated business school in the country, the M.B.A., as the “credential of choice for movement into top management at both large firms and large investors,” will result in “two years of shared training… each of the two sides will have a lingering appreciation for the concerns and challenges of the other.”
The strength of Investor Capitalism lies in its vivid descriptions of personal communications derived from dozens of interviews and Useem’s unique ability to draw on a large number of surveys from other reputable sources. While personal relations will be critical to building the next stage of development, it is also important to examine the process constraints within the current system which shape our everyday behavior.
For example, open-ended mutual funds have liquidity problems which discourage “ownership” and long-term holding. Section 16(b) of the Securities Exchange Act of 1934 requires shareholders with 10% or more of a stock to return short-swing profits, even if the trading was done without inside information. Most pension funds exist in a culture of “blame avoidance” built around the legal concept of “prudence.” Although portfolio theorists generally agree that 99% of the risk management value of diversification can be achieved with a portfolio of only 100 stocks, pension plans continue to over diversify. Congress and/or the Securities and Exchange Commission could provide mechanisms for hybrid “relational” type mutual funds by allowing funds to require some notification prior to withdrawal and by adjusting 16(b) requirements. Congress and/or the Department of Labor could clarify that prudence, under ERISA, is to be evaluated on a portfolio-wide, rather than individual investment basis. The mutual cooperation between long-term owners and corporate executives which Useem envisions appears unlikely to be fully realized, regardless of the benefits of shared educational experiences, unless such structural reforms are made.
Useem notes that “when U.S. company executives describe the relations they have established with investors, few cite other company experiences and none allude to non-U.S. models.” He concludes that “companies have, of necessity, invented their own solutions to the problems of managing a far more concentrated yet still remarkably diverse ownership base.” The increasing use of books such as Michael Useem’s Investor Capitalism, Monks and Minow’s Watching the Watchers, Mark Roe’s Strong Managers, Weak Owners, and Margaret Blair’s Ownership and Control in MBA programs should go a long way, both in reducing the need of company executives to continually reinvent emerging solutions to problems in the area of corporate governance and in furthering their dialogue with shareholders.